Growing Services

As I wrote about last month, Apple continues to evolve into a company that provides (and makes money off of) services. Last quarter, Apple pulled in a total of $84.3 billion. Apple’s services generated $10.9 billion in revenue, up 19% from a year prior. Apple’s services revenue comprised 13% of their total revenue. Although Tim Cook touts Apple as a services company, and many of their most recent moves back that up, they have a long ways to go to diversify their hardware revenue, especially non-iPhone revenue.

Even more importantly, Apple reported its margin in the services category, coming in at 62.8%. Much higher than Apple’s overall margins of 38%. And this is why investors love services – low spend, high profits.

As you can see in the chart below, Apple’s services’ revenue is much more consistent than the cyclical iPhone revenue. As a long term investor, I’m not that concerned about this, but Wall Street loves this consistency.

Google, the App Store, and Lazy Money

Apple’s services’ revenue is growing quickly, it’s consistent, and its margins are thick. The bad news is the bulk of the services’ revenue is coming from lazy money.

WTF is lazy money? Well, in one way it’s good. It’s money you don’t work for. Google, for instance, makes up approximately 20% of Apple’s services revenue by paying Apple for placement in the Safari toolbar. This is great although does come at a cost to the user. Apple could, as they normally do, remain laser-focused on the user experience and choose the search engine that offers users the best UX. With Apple’s privacy focus, DuckDuckGo appears to be an obvious choice for Apple. Instead, Apple gives this real estate to the highest bidder, the not-so-privacy focused Google. I’ll get back to the privacy issue later.

Apple also makes lazy money through the app store. Apple charges 30% to app developers for the sale of an app and/or the first year of a subscription. Apple takes 15% annually from app subscription revenue after that. Some of this revenue is earned. Apple sets guidelines and vets app to protect their users. The App Store also allows users to search and discover apps easily and quickly. But some of this is rent-seeking, such as attempting to take 15% of ongoing revenue from Netflix subscriptions. Netflix has decided they will no longer allow users to subscribe through the app. Again, Apple is arguably sacrificing the UX in order to make lazy money.

SaaS Money

Apple Music and iCloud are more textbook services. With these services, users are signing up for monthly subscriptions that they pay for. These services are sticky. Once a user creates their playlists in Apple Music or gets all of their images/files into iCloud, they become entrenched. But, this isn’t easy money for Apple. Apple will have to continue to maintain and improve these services in order to keep their users.

News, TV, Gaming and More!

The Apple services rumor mill is hot. The Apple News service appears to be coming soon. A TV/Movie service after that and potentially a gaming service down the road.

Apple is leveraging its distribution advantage of the iPhone, iPad, and (to a much lesser extent) AppleTV to launch services. As mentioned last month, this is a sound, but risk-averse strategy.

Apple Privacy

Tim Cook has been harsh on the other tech giants when it comes to privacy. Taking many opportunities to bash Facebook, Google, and others that use the information they have about their user to serve targeted ads. Furthermore, and perhaps their most overstepping behavior, Apple has insisted that every app in the app store disclose when they are recording a user’s behavior.

Although I commend Apple’s respect for user privacy, this is an example of why it’s hard for companies to change what they do. Apple has made money selling computers in many different form factors, but creating a best-in-class service is much different. Good product managers of a service let’s data be their guidance. Every major website we interact with is tracking how their users use it, and this data is used to improve the UX. SaaS 101. Apple’s attempt to take a moral high road will result in inferior services. So far, unlike Apple devices, Apple has yet to make a service that is best in class. Apple Music, Apple Maps, etc may someday have more users than Spotify or Google Maps on iOS devices but that will mostly be because of the value of default apps, not because of a superior service.

Bottom Line

I’m open-minded. We’ll see if I have to eat crow on my assertion that Apple is incapable of making a best-in-class service without sacrificing some privacy. I suspect Apple will eventually start to track behavior to improve the UX and collect information to enhance personalization.

Either way, Apple will make money from these services and the services’ revenue will continue to make up a larger slice of their revenue pie.